The Collapse of Silvergate, svb and Signature Bank: Examining the Causes and Contagion Risks
While the collapse of FTX initially put the business of crypto-friendly banks in spotlight, for Silvergate the problem was not only that FTX has gone away, but other prominent digital asset clients were leaving too.
Crypto companies put tones of deposits in Silvergate and most of them did not receive interest on their deposits. Around 90% of the bank’s deposits belonged to crypto clients.
Then crypto melted down and so crypto investors withdrew their funds from exchanges, which in turn withdrew their funds from Silvergate. Remarkably, noninterest bearing deposits decreased from $12 billion to only $3.9 billion by the end of December 2022.
Silvergate consequently needed $8 billion of cash to cover these withdrawals and so borrowed $4.3 billion from the Federal Home Loan Bank of San Francisco (FHLB). The bank got the rest of the amount needed through selling some of its bond portfolio at a loss and this caused more problems.
Then to repay its outstanding advances from FHLB in full, Silvergate had to sell more of its securities and book more losses, reducing its leverage ratio to less than 5%.
After its major crypto clients withdrew their deposits and the bank shut down its most attractive product, the Silvergate Exchange Network, the bank’s chance of survival significantly decreased. Silvergate had to sell more of its securities, some of which were long-dated bonds, to raise cash. However, unfortunately, the large hikes in interest rates have considerably impaired the value of these securities.
Clearly, the major risk Silvergate took was duration risk. While the bank owned treasury bills and was almost paying 0% interest to depositors, it was also investing in long-dated, although safe, securities like Treasury notes, mortgage-backed securities, US agency securities, and municipal bonds, to obtain more yield. Had the bank parked its funds at the Fed, or short-term Treasury bills, the situation might have been better.
The build up of bank losses worsened the situation, and people became more nervous, and so more clients rushed to withdraw their deposits and the bank had to sell more securities… the classic downward spiral ensued as that behavior continued.
So, who is to be blamed here? Is it the bank for its mismanagement of risk? The Fed for its tightening process? Or the bank’s crypto customers who decided to leave, putting more pressure on the bank that had facilitated and revolutionized their businesses when they really needed a friendly bank?
Thus far, notwithstanding the fall of FTX and the other bankruptcy filings last year, we haven’t seen an enormous risk of contagion from the crypto industry to the traditional banking sector. However, this may be the case lately.
We may all agree that Silvergate did not fail just because it banked crypto. But, if the withdrawal of deposits by crypto firms had forced Silvergate to sell off its securities and become under-capitalized, which eventually led to its failure, then this probably was another victim of the massive failures of last year and a signal of the huge contagion risk.
The case of Silicon Valley Bank (svb)
The collapse of svb followed the collapse of Silvergate in two days and marked the second largest bank collapse in U.S. history.
The Fed interest hikes campaign eroded the values of svb’s long-dated bonds and increased the borrowing costs for tech firms, which weakened the momentum of tech stocks that had greatly benefited the bank.
In unison, venture capital started to dry up, and so tech startups had to withdraw their funds from svb. The bank was then in a pretty difficult position, with the unrealized losses in its securities and the escalating customer withdrawals.
The inconvenient possibility that its depositors may demand their money back was overlooked
by svb. As of December 31, 2022, svb had total assets worth $211.8 billion. However, only
around $40 billion, consisting of cash and available-for-sale securities, were immediately
available and fairly valued to cover the $173 billion deposit liabilities that are due within the next
year, as stated in svb’s contractual obligations table.
The svb crisis started after the bank sold a portfolio consisting mainly of U.S. Treasury bonds,
recording an unrealized loss of $15.5 billion by the end of year 2022 (thanks again to the Fed’s aggressive tightening process to control inflation) and announced a share sale of $2.25 billion to support its balance sheet.
Subsequently, a panic among venture capitals and tech firms had spread, customer confidence had tanked, and the same old-fashioned bank run happened with svb as depositors rushed to withdraw their money, resulting in a total deposit call amounting to $42 billion last Wednesday, that was almost 25% of the total deposit base.
The bank saw a crash in its stock price on Thursday (March 9) and trading in svb shares stopped the very next day.
The bank’s insolvency was not the sole reason for its closure. It triggered fear among depositors,
causing them to withdraw their funds in a traditional bank run, ultimately resulting in the bank’s
shutdown on March 10.
U.S. regulators shut down the bank after taking control of its deposits on Friday (March 10) and the Federal Depository Insurance Corporation (FDIC) was named as a receiver. The Biden administration assured depositors that their funds will be protected and that they could access their funds on Monday (March 13). The government also stated that taxpayers will not carry the burden of any losses associated with resolution of svb.
The FDIC has converted the Deposit Insurance National Bank of Santa Clara to a bridge bank to process certain financial transactions and facilitate access to insured client deposits. FDIC auction for svb assets started Saturday (March 11), however it was not able to find a whole bank buyer over the weekend.
While the core debate last week was around how troubles in the crypto industry may be fueling a banking crisis, the reality seems to be something else! In fact, of the two banks that collapsed last week, the one which was directly focused on crypto, Silvergate Bank, by-passed the black mark of federal support as it did not go into receivership by the FDIC. Instead, it was the tech-focused bank svb, that had a modest tie to digital assets, whose failure necessitated FDIC receivership.
Another Crypto-friendly Bank Failure!
While the Biden administration announced that all depositors of svb could access their funds on Monday (March 13), unfortunately, the announcement came along with the failure of another New York-based commercial bank, Signature Bank. That was certainly a sign of fast-spreading panic across the banking industry.
Indeed, that is what Mike Fay, author of Blockchain Reaction, pointed to in his discussion on investor takeaway from the 2013 Cypriot financial crisis and the recent failure of Silvergate and svb, in the latest article at Seeking Alpha, where he said: “Not your keys, not your coins’ is a lesson that, apparently, has to be learned again and again as history finds ways to repeat”.
The failure of Signature bank, which had a significant number of crypto clients, came along in few days after the collapse of svb. The bank was shut down on Sunday (March 12) by state regulators and the FDIC had taken receivership of it. That marked the failure of the third bank in less than a week, following Silvergate’s voluntary liquidation and SVB’s shutdown on Wednesday and Friday, respectively.
As with svb, U.S. regulators assured that all depositors of Signature bank will get their funds back and that no losses will be borne by taxpayers.
In a second attempt, the FDIC asked banks who are interested in acquiring svb and Signature banks to present their bids by March 17, trying to return the lenders to the private sector.
While a government fund would cover the capital shortages resulting from the resolution of failed banks, this would put a levy on other banks. So, if the FDIC succeeded in its attempt, and the banks got sold, this would minimize shortfalls. However, the FDIC requires that any buyer of Signature bank has to agree to give up all the bank’s crypto business!
The question remaining is why did regulators hurry to shut down Signature? Was this action taken to protect depositors because the bank was exposed? Or was it a purely anti-crypto strategy?
Some consider the shut down of Signature as a clear anti-crypto message from regulators. The founder and CEO of Binance, Changpeng Zhao, said, “It feels like there is a coordinated effort to shut down crypto-friendly banks”, remarking the case of Signature as a prime example.
In the same vein, Barney Frank, a board member at Signature bank, told CNBC that by shutting down Signature bank, “regulators wanted to send a very strong anti-crypto message”, as the bank was solvent when regulators took action.
On the other hand, The New York regulator opposed the claims it shut down Signature in an effort to shut down “crypto-friendly” banks. On Tuesday, the New York financial regulator said the Signature Bank was not closed for crypto-related reasons, but as a result of “a significant crisis of confidence in the bank’s leadership”. While, the bank was eminent in the crypto space and had around 25% of its deposits belonging to crypto customers at the end of September, the bank had a well diversified deposit base prior to its closure.
Nothing is certain so far as to why these banks were shuttered. But definitely, there is one good lesson to be learnt from the failure of these banks:
The entire incident of bank failures emphasizes the argument that customer deposits are not as safe in regulated banks as we might have thought. In such a case, a decentralized peer-to-peer network and seizure-resistant type of currency, like Bitcoin, which enables self-custody of funds appears as a safer option.